Expect a nuclear deal with Iran soon—and another year of cheap oil

This story has been updated with reports that diplomats have reached provisional agreement and will announce a deal Monday (July 13), and with oil prices consequently dropping in early Asian trading.

Despite the deep skepticism in the air, nuclear talks with Iran only seem deadlocked—analysts are still setting the odds in favor of a deal between 60% and 70%. Back in January, we predicted such a deal would be struck this year; reports today are that diplomats have reached provisional agreement, which will be conveyed home for approval, and that a deal is likely to be announced tomorrow morning.

If the reports are right, among the losers will be petro-rulers and oil companies that haven’t seriously trimmed expenses. Oil prices fell in early Monday trading in Asia on the belief that an Iran deal will be announced. Among the winners: oil-consuming states and motorists everywhere, whose dollars will continue to stretch further as oil prices are pushed down.

Why a deal is likely: local politics

Cliff Kupchan of research firm Eurasia Group has long put the odds of a deal at 60%—where most analysts are at the moment—and retains that probability despite the sides missing a July 9 US deadline for an agreement. He said a deal would be concluded within a week (by July 17).

The main driver in these talks between Iran and the six countries negotiating to limit its nuclear activity—France, Britain, China, Russia, Germany and the United States—has been local politics: Notwithstanding his game and defiant face, Iranian leader Ali Khamenei, as he has demonstrated through his two-year support of the talks, sees it in his political favor to reduce tension with the US.

As for the US and the rest of the so-called P5+1, they all support putting a bookend on the three-and-a-half-decade-long ostracization of Iran. The West and Tehran won’t suddenly cozy up; but the successful conclusion of an important diplomatic accord could set the stage for less hysterical relations on other fronts. In terms of those who doubt Iran’s sincerity, it would also establish a more concrete and public baseline from which to act should Tehran cheat.

In a July 9 note to clients, Kupchan said, “The Iranians were very likely using the 9 July ‘deadline’ as leverage on the US. Now, the playing field is level, and strong political will exists on both sides to reach an accord.”

This is going to mean lower oil prices

Such a scenario will mean another sorry year for those whose wherewithal relies on high oil prices. If geopolitics remain more or less at today’s level of mayhem, oil prices will struggle to rise above the band we’ve seen—$55 to $65 a barrel, far below the cost of running most petro-states and oil companies.

This is because of a vicious circle that’s formed between the Organization of Petroleum Exporting Countries (OPEC) and upstart US shale drillers. Since last fall, Saudi-led OPEC has been flooding the market with oil in an attempt to drive down prices, and force shale drillers out of a business that the cartel wants for itself.

Instead, the number of drilling rigs on the US shale patch rose for the second straight week last week after 29 prior weeks of decline. And while overall number of working rigs has fallen in North Dakota’s Bakken basin, the favored target of shale mockers, production there surged in May thanks to more efficient technology, according to a new report. For seven straight weeks, the US has produced 9.6 million barrels of oil a day, its highest rate since the early 1970s.

This US persistence has forced OPEC to continue its elevated drilling. The OPEC countries are producing 31.7 million barrels a day, according to the International Energy Agency (IEA). So even next year, when US shale production will be flat and not grow or shrink, OPEC drilling will keep the world in surplus, the IEA suggests. If OPEC reduces its production, prices will go back up, which will incentivize US shale drillers to go back to work.

On top of that will be new Iranian production

And that’s not all. As soon as the US Congress and Iranian leadership approve a nuclear deal reached in Vienna, Tehran could almost immediately begin to sell the 30-40 million barrels of oil stored in vessels floating off its shores at the moment. At a rate of, say, 200,000 barrels a day, the added flow can last almost six months. That would be right about the time that Iran will start to boost production from existing fields.

All in all, analysts say a reasonable estimate is that Iran will add between 500,000 and 1 million barrels a day to global supply over the next 18 months. Even if shale doubters are right, this oil will maintain OPEC’s current nightmare.

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